US Regulators Use Carrots and Sticks For ICOs and Crypto Investments

US state and federal regulators recently offered carrots to guide market actors toward better behavior and are using the stick of enforcement actions to discourage fraud in ICOs and other cryptocurrency-related offerings.

The US Commodity Futures Trading Commission (CFTC) recently issued guidance for the listing of virtual currency derivative products to registered exchanges and clearinghouses in Staff Advisory No. 18-14, “Advisory with respect to Virtual Currency Derivative Product Listings” (Staff Advisory). In an effort to provide regulatory clarity while helping market participants keep pace with innovation, the Staff Advisory is designed to help market participants design management programs that address virtual currency products. The Staff Advisory clarifies the CFTC staff’s priorities and expectations in its review of new digital currency derivatives to be listed on a designated contract market (DCM) or swap execution facility (SEF), or to be cleared by a derivatives clearing organization (DCO).

The Staff Advisory provides expectations and guidance in five areas: (1) enhanced market surveillance, (2) coordination with CFTC staff, (3) large trader reporting, (4) outreach to stakeholders and (5) DCO risk management. Highlights of the Staff Advisory include a focus on continuously monitoring relevant data deeds to identify manipulation and a recommendation that exchanges set the large trader reporting threshold at five bitcoin, or the equivalent for other virtual currencies, in order to facilitate surveillance of the futures and options market.

The North American Securities Administrators Association (NASAA) announced coordinated enforcement actions by US state and Canadian provincial securities regulators cracking-down on fraudulent initial coin offerings (ICOs), cryptocurrency investment products and their promoters. Operation Cryptosweep involves NASAA members from more than 40 jurisdictions in the United States and Canada and has resulted in 70 inquiries and investigations and 35 pending or completed enforcement actions in only 3 weeks. Additional enforcement actions are expected. Several NASAA members are also conducting public outreach to warn investors of risks associated with ICOs and cryptocurrencies.

The US Securities and Exchange Commission (SEC) Chairman Jay Clayton applauded the efforts, stating that while “there are improvements that can be made to our regulatory system” he supported the effort to crack-down on fraud in the ICO markets. He also noted that “regulators are coordinating on an international level to take strong actions to deter and stop fraud.”

NASAA members’ efforts to educate investors about ICOs were echoed by the SEC’s tongue-in-cheek HoweyCoins.com website. The SEC recently announced the investor education site and related materials to provide guidance by way of example of what the SEC believes are the hallmarks of a scam token offering. The site “mimics a bogus coin offering to educate investors about what to look for before they invest in a scam.” Anyone considering conducting an ICO should also take note of these “classic warning signs of fraud.”

The site includes a countdown clock, promise of guaranteed returns, celebrity endorsements, a statement that the tokens will trade on an “SEC compliant” exchange, the ability to pay with credit cards, and statements to the effect that this is a pump and dump scheme. The site also includes stock photography of beautiful tropical locations and pictures of SEC staff posing as pseudonymous advisors to the project.

The SEC has provided a white paper for the project, complete with enthusiastic but vague descriptions of the business opportunities in the travel industry and a purported description of the world’s monetary system. It promises alliances with various travel partners, including airlines, hotels and resort brands. As on the token sale website, the white paper promises immediate returns and a call that this is a “can’t miss investment opportunity.”

HoweyCoins.com and the accompanying white paper and guidance provide useful information not only to potential investors, but also to anyone contemplating an ICO.

In conclusion, the CFTC’s and SEC’s regulatory guidance and education efforts and the NASAA’s coordinated enforcement actions demonstrate the broad range of tools available to regulators. These recent actions demonstrate that US regulators are providing guidance to allow for technological and market innovation while bringing enforcement actions to curb fear, uncertainty and doubt in our financial markets.